Filling the cracks in PI cover

Vol: 43 Issue: 3 | Oct 2020

Australia’s construction industry has been facing an insurance crisis following alarming revelations of shoddy building practices that have put residents’ lives at risk. 

Cracks appearing in residential high-rises, such as Sydney’s Opal Tower, and the flammable cladding wrapping thousands of apartment buildings across the country have contributed to soaring premiums and limited availability of professional indemnity (PI) insurance.

Can confidence in the construction industry be restored among insurers or will it prove too great a risk for PI cover?

Concerns about the construction industry have been mounting for several years. 

In August 2017 — two months after London’s Grenfell Tower tragedy — the Building Ministers’ Forum commissioned academic and former senior public servant Professor Peter Shergold and lawyer Bronwyn Weir to compile a report on the effectiveness of compliance and enforcement systems for Australia’s building and construction industry.

MAJOR INDUSTRY FLAWS

The report, Building Confidence, identified several flaws in the sector, including insufficient supervision, auditing and expertise across the industry. It also found that too many practitioners were willing to take short cuts to save money and time.

‘The hot-button issue in 2019 was flammable cladding,’ says Chris Bovill, managing director of broker Bovill Risk & Insurance Consultants, which specialises in PI and builders’ insurances.

‘Everyone has now accepted the fact that you can’t get cover for it. The issues that the insureds are now facing are dramatic increases in premiums, reductions in limits of indemnity and huge increases in excesses.’

CRACKS IN PROFESSIONAL INDEMNITY COVER

In July 2019, Landmark Underwriting, then the last remaining provider of exclusion-free PI policies, pulled out of the Australian market, leaving practitioners such as certifiers exposed.

State governments were quick to respond. In Victoria, for example, all building practitioners required to hold PI insurance became eligible to hold policies with exclusions for external wall cladding products from 25 February 2020.

The New South Wales Government passed the Design and Building Practitioners Act in June, as part of sweeping legislative changes aimed at improving transparency and accountability in the sector.

The new law requires construction professionals to declare compliance with the Building Code of Australia and be insured against ‘any liability’. 

Builders, designers, manufacturers and suppliers will also owe a duty of care to current and future building owners to avoid economic loss caused by defects, and the duty of care can be applied retrospectively to any building less than 10 years old.

PROBLEMS IN NEW ZEALAND

Australia is not the only country in the region to experience challenges in its construction industry. In New Zealand, leaky building issues have plagued the nation’s building sector since the 1990s.

Many of New Zealand’s homes built between the late 1980s and 2004 included substandard plaster-style monolithic cladding systems and sealing, which allowed water to seep into the walls. 

As a result, many homes from this period harboured toxic mould.

‘Leaky buildings have been a major problem for New Zealand’s insurance industry,’ says John Sloan, owner of Sloan Risk Management Services. 

‘Many people were left with major repairs without any recourse, because building guarantee insurance had expired by the time problems had emerged or the builders had gone under. 

'Building certifiers and others also had problems getting PI insurance when insurers pulled out of insuring them, in a similar way to the cladding issue in Australia.’

LEAKY EXCLUSIONS

Auckland-based insurance lawyer Crossley Gates says that while most insurers were able to mitigate the impact by adding leaky building exclusions to their policies from 2002, there were still exposures for claims already notified in previous years.

The latent nature of the damage also meant that, despite New Zealand’s six-year limitation period, court proceedings were being brought a decade or more after the buildings had been completed.

‘This delay led to difficulties tracking down the relevant parties and establishing the critical evidence,’ he says.

‘Often the most culpable parties had disappeared or had gone into liquidation, leaving professional advisers with PI insurance, those entities fortunate enough to have public liability insurance and local councils to pick up the cost.’

In 2004, the New Zealand Government brought in new regulations requiring all buildings to have a cavity system to capture any rainwater.

‘A number of PI insurers started providing limited leaky building cover to buildings with that system; however, weather tightness is a multifaceted issue and I understand some of these insurers have suffered a higher incidence of claims than they expected,’ says Gates.

REBUILDING CONFIDENCE IN THE CONSTRUCTION SECTOR

In an article published in ANZIIF’s Journal in September 2019, Campbell Fuller, head of communications and media relations at the Insurance Council of Australia, commented that insurers would ‘need to see changes implemented before they can fairly and reasonably re-engage with the construction sector’.

When asked today if insurers have seen meaningful reforms, Campbell is direct in his response: ‘Nothing significant has changed,’ he says.

However, James Rigney, a disputes and resolutions special counsel focused on the insurance space at law firm Clyde & Co, says there has been a tightening of risk management practices in building consulting firms.

He adds that insurers can mitigate risks by introducing sub-limits in their policies. 

‘Insurers can say that a policy limit is set at $20 million, for example, but also implement a sub-limit for claims in relation to certain matters. This allows them to limit their exposure to certain issues.’

AUDITS REQUIRED

Steven Donley, special counsel in the construction professional indemnity practice at Clyde & Co, says insurers can also mitigate their risk in their PI line by insisting on audits of past building projects.

‘It’s the historic failings in regulation and lax practices from eight or nine years ago that are such a problem for insurers today,’ he says.

‘They’re insuring all the work that a professional does dating back 10 years until the limitation period on legal action expires. The biggest risk for insurers is not what the [building industry] is doing now, it’s what it did within the past decade.’

CRYING WOLF

Despite a considerable tightening of PI cover for the construction industry, Bovill believes that most risks can be underwritten.

‘We’ve just come out of a soft market that has existed since 2004,’ he says. ‘Over the past decade, our clients’ premiums have very rarely gone up. More often, they’ve gradually reduced over that period.

‘All of a sudden, they’ve hit the wall where insurers are correcting the premium. Everyone is crying doom and gloom, but the same thing happened in 2001 when there was a shock to the insurance industry and the market hardened.

‘The scarcity of insurers that would [insure] engineers or building surveyors was exactly the same.’

Bovill believes the ‘good risks’ will continue to get PI insurance. 

‘Those in the industry who have not bothered to develop their professionalism, their risk management procedures, their systems and processes internally, are the ones who will face problems.’

DEFECTIVE BUILDING DESIGNS CAUSING GRIEF FOR INSURERS

    1.  1994 – 2004, New Zealand

Leaky buildings crisis

Tens of thousands of ‘leaky’ houses and apartments were constructed in New Zealand causing structural problems and health issues for residents. A 2009 PwC report estimated it would cost up to NZ$11.3 billion to repair all the faulty buildings.

    2.  2014, Melbourne

Lacrosse Tower

Fire fuelled by flammable cladding raced up 13 levels of Melbourne’s residential Lacrosse Tower in November. In February 2019, owners of the apartments were awarded more than A$5.7 million in damages.

    3.  2017, London

Grenfell Tower

Fire at London’s Grenfell Tower killed 72 people and prompted the Australian Government to launch an inquiry into its building and construction system.

    4.  2018, Sydney

Opal Tower

Residents of the 36-level Opal Tower in Sydney were evacuated after the concrete in the building’s walls and floors cracked on Christmas Eve. The developer has spent A$31 million repairing the building.

    5.  2019, Melbourne

Neo200

A fire quickly spread up eight floors of the residential Neo200 tower in Melbourne in February, with fire investigators finding defects in a number of the building’s safety measures.

    6.  2019, Sydney

Mascot Towers

Mascot Towers in Sydney’s inner-south was closed to residents in June after cracks were found in its car park.